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January 29, 2016 8:50 am
China floods banks with record amount of cash
Gabriel Wildau in Shanghai
China flooded its banking system with record amounts of cash this week to meet elevated holiday demand and hedge the impact of capital outflows that risk draining much-need liquidity from the economy.
Cash demand typically spikes ahead of China’s lunar new year holiday that begins on February 8 this year, as companies pay taxes and parents give hongbao — red envelopes filled with money — to children and extended family.
But in addition to the usual seasonal factors, liquidity has been further strained this year by accelerating capital outflows driven by fear of renminbi weakness and waning confidence in the Chinese economy. Falling Chinese interest rates combined with the Federal Reserve's rate rise have also helped draw funds out of China.
The People's Bank of China injected a net Rmb690bn ($105bn) into the banking system this week through open market operations — the largest single-week injection on record — including a highly unusual injection on Friday morning. Normally the PBoC conducts such operations only on Tuesday and Thursday, but the central bank said on Thursday it would increase the frequency of its cash injections through February 19.
The central bank finds itself attempting a tricky balancing act. It must avoid fuelling further renminbi weakness and capital flight through excessive easing.
At the same time, it must create new money to replace the liquidity drained from the system through capital outflows in order to ensure that loans keep flowing to the real economy.
The central bank's use of its foreign-exchange reserves to curb renminbi depreciation adds to the challenge of preventing a liquidity crunch. When the PBoC sells dollars, the renminbi it receives in exchange are drained from the money supply.
In a meeting with commercial banks last week leaked to local media, the PBoC said it was unlikely to enact further cuts to the required reserve ratio (RRR), which sets the portion of deposits that banks must hold in reserve at the central bank where they are unavailable for lending.
"The PBoC wants to avoid exacerbating capital outflows and adding to (renminbi) depreciation by opting to use shorter-term liquidity tools when needed, rather than employ the blunter tool of RRR cuts," Barclays analysts wrote this week.
Cash injected through twice-weekly open market operations is typically short-term money. The repurchase agreements conducted this week carried seven- and 28-day maturities, meaning the newly created money will disappear from the system in less than a month.
Of greater significance is the net Rmb613bn that the PBoC has injected this month via its medium-term lending facility, which provides loans to commercial banks. These loans are often rolled over on maturity, meaning that the recent injections likely represent a long-term expansion in the money supply.
Compared to RRR, open market operations and medium-term lending are more flexible ways to create new money. Whereas an RRR is permanent unless the PBoC reverses it, the central bank can passively allow medium-term loans and open market operations to expire if authorities judge that liquidity has become too flush.
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